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If you think that planning for retirement means that you’re going to need to become an expert at investing or managing your funds all day, then I’ve got great news for you: You don’t! Lots of people from all around the world have reached millionaire status without ever doing much more than just being clever with their spending, or not spending, that is.
Just like you don’t need to be a chef to enjoy good food or an engineer to drive a car, you certainly don’t have to become an expert in all things financial to build a comfortable nest egg. What you do need is to hit just a few key areas of your savings that will really give you the most bang for your buck with every dollar that you save.
I’m a big believer in something called the 80-20 rule. Simply put, this is a theory that says that 80 percent of the results are achieved by 20 percent of the inputs. If we can just get you to focus on doing those top 20 percent of the things you need to do with your money and ignore everything else, then you’re going to be doing awesome.
Here are three areas of your finances I want you to focus on that believe are that “top 20 percent” and will without a doubt improve your life for the better.
Contribute to Your Retirement Plans
There’s not just one reason that nearly every financial expert out there recommends you use your retirement plans (like a 401k or IRA) to build your nest egg. There are actually three!
When you put your money into your retirement plan, you’re given a free pass to not have to pay taxes on it for the year. Although that may not sound like a lot, that’s some pretty major savings!
Imagine for a minute that you saved $10,000 in your 401k this year. If you had tried to save this same money in an after-tax savings or investment account, you would have had to pay taxes on it.
If we just generically assume 25%, then that would mean $2,500 would have gone to the government. But not for you! By being smart and saving it in a tax-deferred retirement plan, you get to keep the whole thing for yourself.
Remember that the money inside your retirement plans is actually invested across a variety of funds made of stocks, bonds, and other assets. As the markets move and grow with time, so will your investments.
When it comes to your savings, this creates something awesome called compounding returns. Compounding returns are effectively the money you earn off the money you contributed plus any previous earnings that have been accumulated.
Basically, as you set aside money each month, that money will grow in earnings. And then those earnings will also grow with additional earnings, and so on. Though that doesn't seem like much in the beginning, after several years, your earnings will actually start to add more to your overall nest egg value than your contributions will!
You can see this in action for yourself using any free compound interest calculator such as this one here. Just type in a few numbers and you’ll see how over time compounding returns become a force to be reckoned with!
401k Employer Matching Contributions
If your employer offers matching contributions as part of their 401k plan, then you absolutely want to start taking full advantage of this right away! It will be the easiest money you’ve ever earned in your life, and it will be all for doing nothing more than just being a good saver.
How do employer 401k employer matching contributions work? Let’s say your company matches dollar-for-dollar up to 5 percent of what you’re saving for retirement. If 5 percent equals $150 per paycheck, then that means your employer will also kick in an extra $150 on top of your savings for a total of $300 saved.
That’s effectively a 100 percent return on your money. Where in the world can you find a better deal than that?
And if that’s not sweet enough, remember that just like your contributions, those employer contributions will also be tax-deferred and invested for compound growth. That’s just going to help build your nest egg up even quicker!
Pay Off Your High-Interest Debt
Debt can be a pretty big drag on your finances. But when managed strategically, there are some actions you can take that will save you tons of money in the long run.
Here’s what I mean: Remember that debt carries interest. When you pay off your debt ahead of schedule, you no longer have to pay the interest that you owe.
Think about your mortgage or credit card balance. When you make a payment toward the principal (beyond the required minimum), it reduces the interest calculation and lowers your payments in the future. In some cases, that can save you tens or even hundreds of thousands of dollars over the life of the loan.
This is why it's helpful to think of paying your debt as basically the same thing as interest you earned on an investment. From there, the opportunities for your money become a simple question of percentages.
For instance, would you rather put your money into an online savings account earning 1 percent interest or pay off your credit card that has a 20 percent APR? When you put it in the context that we just described above, paying off the credit card makes way more sense because you’re effectively saving yourself from signing up to owe someone else 20 percent interest in the future.
And let’s also not forget: The sooner you pay off your debts, the more money you’ll have to put towards your other savings goals.
Build Up Your Emergency Fund
We all know bad stuff will happen. Your car will make a funny noise, you’ll find a leak in your basement, or you'll have to go to the hospital when you least expect it. To handle these kinds of things financially, you’re going to need cash that you can easily tap in a moment’s notice to handle these emergencies right away.
Most financial professionals will tell you that your emergency fund needs to be anywhere from 3 months to 6 months worth of your household expenses. Some people will even say that number should be as high as 12 months expenses.
While you might think that having that much money sitting around in a savings account earning almost nothing is a complete waste of resources, I can assure you: It’s not! An emergency fund isn’t an investment account, it's an insurance policy. It’s the safety net between you and financial disaster.
Most people don’t realize it, but they are one accident away from financial ruin. Think about what would happen if you were suddenly hit with a $10,000 expense you didn’t see coming. Without an emergency fund, most people would put this on their credit card or even take out a personal loan – both of which would mean super-high interest to pay back.
But when you have an emergency fund, that’s not going to happen. You save yourself the trouble of getting into debt and having to pay back all that interest. You keep a bad situation from becoming worse.
That’s why I say follow the advice of the experts. Start building your emergency fund today and put a protective wall between disaster and your finances.
Final Thoughts on Improving Your Finances
Remember: You don’t have to be a stock-picking wizard or MBA graduate to be successful with your finances. Taking full advantage of your retirement funds, eliminating your high-interest debt, and protecting yourself with a decent-sized emergency fund is all that you need to do. Focus on these three core areas, and you’ll definitely be putting the 80-20 rule to work for you and your money!
Contributor’s opinions are their own. Always do your own due diligence before investing.
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